IRAs and Retirement Plans

Transcription

1 SELF-STUDY CONTINUING PROFESSIONAL EDUCATION IRAs and Retirement Plans Fort Worth, Texas (800) cl.thomsonreuters.com/q

2 Copyright 2010 Thomson Reuters/Gear Up All Rights Reserved This course, or parts thereof, may not be reproduced in another document or manuscript in any form without the permission of the publisher. This publication is designed to provide accurate and authoritative information in regard to the subject matter covered. It is sold with the understanding that the publisher is not engaged in rendering legal, accounting, or other professional service. If legal advice or other expert assistance is required, the services of a competent professional person should be sought From a Declaration of Principles jointly adopted by a Committee of the American Bar Association and a Committee of Publishers and Associations. Gear Up is registered with the National Association of State Boards of Accountancy (NASBA) as a sponsor of continuing professional education on the National Registry of CPE Sponsors. State boards of accountancy have final authority on the acceptance of individual courses for CPE credit. Complaints regarding registered sponsors may be addressed to the National Registry of CPE Sponsors, 150 Fourth Avenue North, Suite 700, Nashville, TN Website: Gear Up is registered with the National Association of State Boards of Accountancy (NASBA) as a Quality Assurance Service (QAS) sponsor of continuing professional education. State boards of accountancy have final authority on acceptance of individual courses for CPE credit. Complaints regarding QAS program sponsors may be addressed to NASBA, 150 Fourth Avenue North, Suite 700, Nashville, TN Website: CFP, CERTIFIED FINANCIAL PLANNER, and are certification marks owned by the Certified Financial Planner Board of Standards, Inc. These marks are awarded to individuals who successfully complete CFP Board s initial and ongoing certification requirements. Registration Numbers New York Texas NASBA Registry NASBA QAS 017 ii

3 INTRODUCTION IRAs and Retirement Plans is an interactive self-study CPE course designed to enhance your understanding of the latest issues in the field. To obtain credit, you must log on to our Online Grading System at OnlineGrading.Thomson.com to complete the Examination for CPE Credit by September 30, Complete instructions are included below and in the Testing Instructions on page 131. Taking the Course You are asked to read the material and, during the course, to test your comprehension of each of the learning objectives by answering self-study quiz questions. After completing each quiz, you can evaluate your progress by comparing your answers to both the correct and incorrect answers and the reason for each. References are also cited so you can go back to the text where the topic is discussed in detail. Once you are satisfied you understand the material, answer the examination questions which follow each lesson by recording your answer choices by logging on to our Online Grading System. Qualifying Credit Hours QAS or Registry Gear Up is registered with the National Association of State Boards of Accountancy as a sponsor of continuing professional education on the National Registry of CPE Sponsors (Registry) and as a Quality Assurance Service (QAS) sponsor. Part of the requirements for both Registry and QAS membership include conforming to the Statement on Standards of Continuing Professional Education (CPE) Programs (the standards). The standards were developed jointly by NASBA and the AICPA. As of this date, not all boards of public accountancy have adopted the standards. This course is designed to comply with the standards. For states adopting the standards, recognizing QAS hours or Registry hours, credit hours are measured in 50-minute contact hours. Some states, however, require 100-minute contact hours for self study. Your state licensing board has final authority on accepting Registry hours, QAS hours, or hours under the standards. Check with the state board of accountancy in the state in which you are licensed to determine if they participate in the QAS program and allow QAS CPE credit hours. This course is based on one CPE credit for each 50 minutes of study time in accordance with standards issued by NASBA. Note that some states require 100-minute contact hours for self study. You may also visit the NASBA website at for a listing of states that accept QAS hours. Credit hours for CPE courses vary in length. Credit hours for this course are listed on the Overview page. CPE requirements are established by each state. You should check with your state board of accountancy to determine the acceptability of this course. We have been informed by the North Carolina State Board of Certified Public Accountant Examiners and the Mississippi State Board of Public Accountancy that they will not allow credit for courses included in books or periodicals. Obtaining CPE Credit Log on to our Online Grading Center at OnlineGrading.Thomson.com to receive instant CPE credit. Click the purchase link and a list of exams will appear. You may search for the exam by selecting Gear Up/Quickfinder in the drop-down box under Brand. Payment of $27 for the exam is accepted over a secure site using your credit card. For further instructions regarding the Online Grading Center, please refer to the Testing Instructions located at the beginning of the examination. A certificate documenting the CPE credits will be issued for each examination score of 70% or higher. iii

4 Obtaining CFP Credit To receive CFP credit, please provide your name and CFP license number to Thomson Reuters within the Online Grading Center. Upon successful completion of the course, we will submit the credit hours you ve earned directly to the CFP Board. The CFP Board will then send you a confirmation that includes the number of credits you have been awarded and the category in which they were earned. If we do not receive your name and license number within 30 days of completion, the CFP Board will not award you credit. Retaining CPE Records For all scores of 70% or higher, you will receive a Certificate of Completion. You should retain it and a copy of these materials for at least five years. PPC In-House Training A number of in-house training classes are available that provide up to eight hours of CPE credit. Please call our Sales Department at (800) for more information. iv

5 IRAs and Retirement Plans (DIRTG10) OVERVIEW COURSE DESCRIPTION: PUBLICATION/REVISION DATE: PREREQUISITE/ADVANCE PREPARATION: CPE CREDIT: CTEC CREDIT: CFP CREDIT: FIELD OF STUDY: This interactive self-study course covers the requirements of traditional and Roth IRAs, Simple IRAs, SEP plans, 401(k) and 403(b) plans, as well as distributions and rollovers from the various plans. September 2010 Basic knowledge of taxation 4 QAS Hours, 4 Registry Hours 4 Federal CTEC Hours, 0 California Hours Check with the state board of accountancy in the state in which you are licensed to determine if they participate in the QAS program and allow QAS CPE credit hours. This course is based on one CPE credit for each 50 minutes of study time in accordance with standards issued by NASBA. Note that some states require 100-minute contact hours for self study. You may also visit the NASBA website at for a listing of states that accept QAS hours. Enrolled Agents: This CPE course is designed to enhance professional knowledge for Enrolled Agents. Gear Up is a qualified CPE Sponsor for Enrolled Agents as required by Circular 230 Section 10.6(g)(2)(ii). 2 CE Hours CFP credit hours are one half the number of CPE credit hours. Taxes EXPIRATION DATE: September 30, 2011 KNOWLEDGE LEVEL: Basic v

6 LEARNING OBJECTIVES Lesson 1: Traditional IRAs Completion of this lesson will enable you to: Identify the requirements of traditional IRAs and retirement annuities, determine contribution limits and requirements for IRAs, what is allowed for IRA contributions and how IRAs are transferred in divorce and inheritance. Lesson 2: Roth IRAs Completion of this lesson will enable you to: Recognize the differences between a Roth IRA and a traditional IRA, determine the requirements for contributing to a Roth IRA and identify the limits and ways to convert to and distribute from a Roth IRA. Lesson 3: SIMPLE IRA Plans Completion of this lesson will enable you to: Describe the various aspects of SIMPLE IRA plans, benefits, and requirements. Lesson 4: SEP Plans Completion of this lesson will enable you to: Identify the requirements of SEP plans. Lesson 5: 401(k) and 403(b) Plans Completion of this lesson will enable you to: Identify the various requirements of 401(k) and 403(b) plans, compare and contrast these types of plans, and determine the allowable contributions to these types of plans. Lesson 6: Distributions Completion of this lesson will enable you to: Determine when IRA and qualified plan distributions are allowed, when they are required, how much is taxable, and when penalties apply to the distribution. Lesson 7: Rollovers Completion of this lesson will enable you to: Determine the requirements for a tax-free rollover of all types of retirement plans and which types of plans can be rolled over into other types of retirement plans. ADMINISTRATIVE POLICIES For information regarding refunds and complaint resolutions, dial (800) , select the option for Customer Service, and your questions or concerns will be promptly addressed. vi

7 CPE & Training Solutions Powered by Checkpoint Learning! checkpointlearning.thomsonreuters.com Online Courses and Learning Management Checkpoint Learning New! Checkpoint Learning...a dream come true for CPE decision makers. With the combined power of MicroMash, PASS Online, and Reqwired, we are pleased to introduce you to the next level in online learning! Checkpoint Learning provides reporting, learning reminders and prompts, CPE compliance tracking, and much more. You can purchase and complete courses directly from Checkpoint Learning, either individually or as part of a subscription package. Select from hundreds of online and downloadable courses on auditing, tax, management, yellow book, and staff training topics. Contact us today to discuss your training needs and begin building a learning plan that s right for you. MicroMash A trusted provider of technology-based CPE and training for over 20 years. Choose from over 150 courses on hot topics that will help you stay on top of your field now available through Checkpoint Learning! PASS Online A CPE provider since 1990, PASS Online offers 240 courses covering a variety of accounting and tax topics, including industry-leading state ethics training courses for accountants. Now available through Checkpoint Learning! Live Seminars & Conferences Gear Up Seminars, Workshops and Conferences A leading provider of tax and accounting education for 39 years, Gear Up offers nationwide events designed for you! Seminars: Half-day to two-day seminars in states nationwide! Select from our 1040 and Business Entities seminars, plus specialty titles including the new Assisting Small Business from A to Z. Conferences: Our week-long CPE conferences are held at exciting vacation destinations! In 2010, join us at Jackpot in Las Vegas (May 17 22), the new Citrus Week in Orlando (June 14 17), Windy City Week in Chicago (August 2 7), Royal Flush in Las Vegas (November 29 December 4), and Magic Week in Orlando (December 14 18). Workshops: Our 8-hour workshop format provides a streamlined learning experience at an affordable price! Accounting and tax titles available this year in Alabama, Florida, Illinois, North Carolina, and Texas. PPC and AuditWatch Conferences PPC and AuditWatch offer in-depth learning at conferences created to meet the needs of professionals nationwide. We gather field experts who bring attendees the most up-to-date, relevant information on important topics Conferences include: PPC Conference on Tax Planning for Wealth Preservation San Francisco, July AuditWatch National School for Audit Leaders San Francisco, July & New York, August PPC and AuditWatch Accounting & Auditing Conference Las Vegas, October 5 PPC and AuditWatch Conference on Audit Quality & Efficiency Las Vegas, October 6 7 PPC Users Conference: Best Practices in Implementing the PPC Approach Las Vegas, October 8 AuditWatch Live Seminars AuditWatch, the audit profession s premier training and consulting firm and recognized leader in audit productivity, offers specialized auditing seminars in locations nationwide. For more details and a seminar schedule, visit trainingcpe.thomson.com/auditwatch. Also available: AuditWatch University an integrated development curriculum with five progressive levels of audit staff training available, plus a new web-based New Hire training option and TaxWatch University progressive levels of tax training brought to you by PPC In-House Training and AuditWatch. CINS010

8 In-House Training PPC In-House Seminars PPC offers on-site customized training on over 50 accounting and auditing, management, staff training, tax and Yellow Book topics. This learning experience is custom-tailored to meet your needs, taught by highly rated instructors, features current, relevant course content and at approximately $15 per credit hour, In-House training is very affordable! Practitioners Monthly Video Digest This monthly CPE product is a convenient and cost-effective way for firms to provide timely, leading-edge in-house training. Every month (excluding February and March) your firm will receive a training module that contains a highquality instructional DVD and related course materials including an instructor s guide and participant materials. Members of your firm will meet monthly, view a DVD featuring leading experts addressing new and emerging issues, and participate in related discussions. Webinar Learning Network You ll find webinars on the latest developments in tax, accounting, auditing, finance and more all you need is a high-speed internet connection and a phone! AuditWatch AuditWatch has an intense focus on serving the audit and accounting profession with leading experts to train and consult with firms that provide auditing services. Our integrated development curriculum for audit professioanls and CPA firms, audit process consulting, and audit technology services make AuditWatch the recognized leader in audit productivity. Self-Study Courses Gear Up Self-Study A leading provider of tax and accounting education for 39 years, Gear Up offers print-based self-study courses based on our popular live seminars plus additional standalone specialty topics. Most live seminar topics can be supplemented with video and audio materials to provide you with the feel of an instructor-led seminar in your home or office learn on your schedule! PPC Self-Study Learn with the company that provides the industry-leading PPC Guides convenient self-study courses are available on a variety of accounting & auditing and tax topics. Easily access many print-based self-study courses as downloadable PDFs and complete your CPE exams online for immediate results, now directly through the new Checkpoint Learning platform! Quickfinder Gear Up Self-Study CPE Quickfinder s trusted content combined with Gear Up s history as a leader in tax & accounting professional education a winning combination for your training needs! RIA Self-Study CPE RIA and PPC s Complete Analysis of the Tax and Benefits Provisions of the American Recovery and Reinvestment Act, and RIA s 2010 Federal Tax Review. Download PDF at no cost from Checkpoint Learning! TAX & ACCOUNTING CINS010

9 Table of Contents Lesson 1: Traditional IRAS... 1 What Is a Traditional IRA?... 1 Contribution Limit... 2 When Can Contributions Be Made?... 4 Deducting IRA Contributions... 5 Nondeductible Contributions... 6 Excess Contributions... 7 IRA Transfers Related to Divorce... 7 Inherited IRAs... 8 Tax Credit for IRA Contribution... 9 Prohibited Transactions... 9 Lesson 2: Roth IRAs What Is a Roth IRA? Contributing to a Roth IRA Converting IRAs to Roth IRAs Recharacterizing IRA Contributions and Conversions Reporting a Recharacterization Rollovers from an Employer Plan to a Roth IRA Rollovers from a Roth IRA Failed Conversions and Rollovers Roth IRA Distributions Required Minimum Distribution Rules for Roth IRAs Recognizing Losses on Investments Lesson 3: SIMPLE IRA Plans What Is a SIMPLE IRA Plan? Who Can Set Up a SIMPLE IRA Plan? Contributions to a SIMPLE IRA Plan Tax Treatment of Contributions Distributions (Withdrawals) from SIMPLE IRAs Lesson 4: SEP Plans What Is a SEP Plan Setting Up a SEP Plan Formal Written Agreement Covered Employees SEP Plan Contributions Excess Contributions Lesson 5: 401(k) and 403(b) Plans What Is a 401(k) Plan? Setting Up a 401(k) Plan Employees Who Must Be Covered (k) Plan Contributions Limit on Additions to Any Participant s Account Safe-Harbor 401(k) Plans vii

10 Automatic Enrollment 401(k) Nondiscrimination Rules Excess Deferrals Participant Loans (b) Plans Designated Roth Accounts Lesson 6: Distributions IRA Distributions Qualified Plan Distributions Loans Treated as Distributions Required Minimum Distributions Hardship Distributions from 401(k) Plans Tax on Early Distributions Tax on Excess Accumulations Lump-Sum Distributions from Qualified Plans Dividing Retirement Accounts in Divorce Lesson 7: Rollovers Overview Rollovers from IRAs Rollovers from SIMPLE IRAs Rollovers from Qualified Plans Rollovers from Designated Roth Accounts Tax Withholding Requirements Time Limit for Making a Rollover Waiting between IRA Rollovers Consequences of Failed Rollovers Index Glossary To enhance your learning experience, the final examination questions are located throughout the course reading materials. Please look for the exam questions following each lesson. Testing Instructions for Examination for CPE Credit viii

11 Lesson 1: Traditional IRAS Learning Objectives Completion of this lesson will enable you to: Identify the requirements of traditional IRAs and retirement annuities, determine contribution limits and requirements for IRAs, what is allowed for IRA contributions and how IRAs are transferred in divorce and inheritance. What Is a Traditional IRA? An individual retirement arrangement (IRA) can be either an individual retirement account or an individual retirement annuity. A traditional IRA is any IRA that is not a Roth IRA or a SIMPLE IRA. Tax advantages of a traditional IRA: Contributions to the IRA may be fully or partially deductible. Generally, amounts in a traditional IRA (including earnings and gains) are not taxed until distributed. Certain individuals can claim a tax credit for traditional IRA contributions. Individual Retirement Accounts An individual retirement account is a trust or custodial account created by a written document and set up in the U.S. for the exclusive benefit of an individual or his beneficiaries. The document must show that the account meets all of the following requirements: 1. The trustee or custodian is a bank, a federally insured credit union, savings and loan association or entity approved by the IRS to act as trustee or custodian. Note: An individual cannot be an IRA trustee. 2. The trustee or custodian generally cannot accept contributions of more than the contribution limit for the year. Exception: Rollover contributions and employer contributions to a simplified employee pension (SEP) can be more than this amount. 3. Contributions, except for rollover contributions, must be in cash. 4. The individual s interest in the account balance is nonforfeitable. 5. Funds in the account cannot be used to buy a life insurance policy. 6. Assets in the account cannot be combined with other property, except in a common trust fund or common investment fund. 7. The required minimum distribution (RMD) rules must be followed. Individual Retirement Annuities An individual retirement annuity can be set up by purchasing an annuity contract or an endowment contract from a life insurance company. An individual retirement annuity must be issued in the individual s name as the owner, and either he or his beneficiaries who survive him are the only ones who can receive the benefits or payments. 1

12 An individual retirement annuity must meet all the following requirements: 1. The owner s entire interest in the contract must be nonforfeitable. 2. The contract must provide that the owner cannot transfer any portion of it to any person other than the issuer. 3. There must be flexible premiums so that if the owner s compensation changes, his payment can also change (for contracts issued after November 6, 1978). 4. The contract must provide that contributions cannot be more than the contribution limit for an IRA for the year, and that the owner must use any refunded premiums to pay for future premiums or to buy more benefits before the end of the year after the year the refund is received. 5. The RMD rules must be followed. Contribution Limit Note: Contributions to a SEP IRA are subject to different limits than those described in this section. Also, SEP IRA contributions do not affect the contribution limit for other traditional IRAs. Individuals can make IRA contributions any year that they are eligible to set up an IRA. Contributions must be in the form of money (cash, check or money order). Property cannot be contributed. Exception: Certain property (such as stock) may be transferred from one retirement plan to another. For 2010, the maximum contribution (not counting rollovers) to a traditional IRA is the smaller of: $5,000 ($6,000 if age 50 or older at the end of the year), or Compensation for the year. Example: George, age 34 and single, earns $24,000 in His IRA contributions for 2010 are limited to $5,000. Ethan, an unmarried college student working part time, earns $3,500 in His 2010 IRA contributions are limited to $3,500, the amount of his compensation. This limit applies even if some or all of the contributions are nondeductible. Exception: Qualified reservist repayments are not counted toward this limit. For individuals with more than one IRA, the limit applies to the total contributions made to all their traditional IRAs for the year. Caution: Any contributions over the limit may be subject to a penalty tax. Observation: Traditional IRA contributions reduce the taxpayer s annual limit on Roth IRA contributions. Spousal IRAs For 2010, if an individual files a joint return and his taxable compensation is less than his spouse s, the limit on contributions to his IRA for the year is the smaller of: [IRC 219(c)] $5,000 ($6,000 if age 50 or older) or The sum of the individual s and spouse s compensation, less contributions for the year made to the spouse s traditional or Roth IRA. 2

13 Thus, the total combined contributions that can be made for the year to both spouses IRAs can be as much as $10,000 ($11,000 if only one is age 50 or older, or $12,000 if both are age 50 or older). What Is Compensation? For the IRA contribution limit, compensation is generally what is earned from working. For married individuals, compensation is computed separately, without considering any community property laws. Compensation includes the following: Compensation for IRA Purposes Item Wages, Salaries, etc. Commissions Self- Employment Income Alimony Military Differential Pay Nontaxable Combat Pay Description Any amount properly shown in box 1 (Wages, tips, other compensation) of Form W-2, provided that amount is reduced by any amount properly shown in box 11 (Nonqualified plans). This includes wages, salaries, tips, professional fees, bonuses, and other amounts received for providing personal service. Scholarship and fellowship payments are included only to the extent shown in box 1 of Form W-2. An amount received that is a percentage of profits or sales price is compensation. Net earnings from a self-employed individual s (sole proprietor s or partner s) trade or business (provided the taxpayer s personal services are a material income-producing factor) reduced by: 1) The deduction for contributions made to the self-employed person s retirement plans. 2) The deduction for one-half of their self-employment taxes. Observation: Compensation includes earnings from self-employment even if the earnings are not subject to SE tax because of the individual s religious beliefs. (Exemption generally obtained by filing Form 4029.) Note: Do not subtract a net loss from self-employment from salaries or wages when figuring total compensation. Any taxable alimony and separate maintenance payments received under a decree of divorce or separate maintenance. Payments made by some employers to employees who have been called to active duty in the uniformed services for a period of more than 30 days. These payments are reported in box 1 (Wages, tips, other compensation) of Form W-2. Nontaxable combat pay received by members of the U.S. Armed Forces. This amount should be reported in box 12 of Form W-2 with code Q. What is not compensation? Compensation does not include any of the following items: Earnings and profits from property, such as rental income, interest income, and dividend income. Pension or annuity income (including social security benefits). Deferred compensation (compensation payments postponed from a past year). Income from a partnership if the taxpayer does not provide services that are a material factor in producing income. Any amounts (other than combat pay) excluded from income, such as foreign earned income and housing costs. 3

14 Contributing Less Than the Maximum If contributions to a traditional IRA for a year are less than the limit for that year, additional contributions cannot be made after the due date of that year s return to make up the difference. Example: Rafael, who is 40, earns $30,000 in Although he can contribute up to $5,000 to his IRA for 2010, he contributes only $3,000. After April 15, 2011, Rafael cannot make up the difference between his actual contributions for 2010 ($3,000) and his 2010 limit ($5,000). Any contributions made after April 15, 2011 through the end of 2011 are counted as 2011 contributions and subject to the 2011 limit. The unused 2010 limit is lost. Contributing More Than the Maximum If IRA contributions for a year are more than the limit, the excess contribution can be applied to a later year if the contributions for that later year are less than the maximum allowed for that year. However, a penalty tax may apply. When Can Contributions Be Made? Contributions can be made to a traditional IRA for each year that the account owner: Receives compensation, and Has not reached age 70½. Individuals reach age 70½ on the date that is six calendar months after the 70th anniversary of their birth. Thus, individuals born on or before June 30, 1940 cannot contribute to their own traditional IRA for 2010 or any later year. Strategy: Compensation earned by a married taxpayer who is over age 70½ is still counted for determining his spouse s maximum contribution if they file a joint return and the spouse is under age 70½. Observation: Individuals who do not work during the year can still make IRA contributions for that year if they received alimony, nontaxable combat pay or military differential pay, or if they filed a joint return with a spouse who had compensation. Contributions Must Be Made By Due Date of Return Contributions can be made to a traditional IRA for a year at any time during that year or by the due date (not including extensions) for filing the tax return for that year. For most individuals, this means that contributions for 2010 must be made by April 15, Contributions made after year-end. If an amount is contributed to a traditional IRA between January 1 and April 15, it is necessary to tell the IRA trustee or custodian (sponsor) which year (the current or previous year) the contribution is for. If the individual does not tell the sponsor which year a contribution is for, the sponsor can assume, and report to the IRS, that the contribution is for the current year (the year the sponsor received it). Filing before a contribution is made. Taxpayers can file their return claiming a traditional IRA contribution before the contribution is actually made, as long as the contribution is made by the unextended due date of the return. 4

15 Contributions in the Year of Death A decedent s estate cannot make contributions to the decedent s IRA or to a spousal IRA for the decedent s spouse. However, a nonworking spouse may make a contribution to a spousal IRA for the year of the decedent s death. Example: Brian died on June 8, Before his death, he received $45,000 in earned income. His wife, Jamie, does not have any earned income. Brian s estate cannot make IRA contributions to his IRA or to a spousal IRA for Jamie. However, if she files a joint return with Brian for 2010, Jamie (age 40) can contribute up to $5,000 (lesser of $45,000 or $5,000) to her IRA for 2010 under the spousal IRA rules as long as she, and not Brian s estate, contributes the funds. Variation: Same facts except that in February 2010, Brian made an IRA contribution. Since the contribution was made before his death, it is a qualifying contribution. Deducting IRA Contributions General Rule Taxpayers who are not covered by an employer retirement plan during any part of the year can deduct contributions to their traditional IRA for the year, up to the contribution limit IRA Deduction Limit Under age 50 $5,000 (or compensation, if less) Age 50 or older $6,000 (or compensation, if less) Trustees fees. Trustees administrative fees that are billed separately and paid in connection with a traditional IRA are not deductible as IRA contributions. However, they may be deductible as a miscellaneous itemized deduction on Schedule A (Form 1040). Brokers commissions. If paid by the account owner (rather than out of funds in the IRA), these commissions are part of the IRA contribution and are deductible, subject to the deduction limits. Individuals Covered By Employer Retirement Plans If an individual (or his spouse) is covered by an employer retirement plan, he may not be able to deduct the full amount of his traditional IRA contributions. The deductible amount begins to decrease (phase out) when modified AGI rises above a certain amount and is eliminated altogether when it reaches a higher amount. 5

16 Nondeductible Contributions Although the deduction for IRA contributions may be reduced or eliminated, IRA contributions can be made to the contribution limit. The difference, if any, between the contribution limit and the IRA deduction is a nondeductible contribution. Example: Tony is 29 years old and single. In 2010, he was covered by a retirement plan at work. His salary is $57,312. His modified AGI is $68,000. Tony makes a $5,000 IRA contribution for Because he was covered by a retirement plan and his modified AGI is above $66,000, he cannot deduct his $5,000 IRA contribution. He must designate this contribution as a nondeductible contribution by reporting it on Form Reporting Nondeductible Contributions Form 8606 must be filed to designate contributions as nondeductible. Taxpayers do not have to designate a contribution as nondeductible until they file their tax return. Form 8606 must be filed to report nondeductible contributions even if the taxpayer does not have to file a tax return for the year. In that case, the Form 8606 is filed at the same time and with the same service center as the taxpayer would have filed a tax return if one were required. Observation: Contributions in excess of the allowable deduction must be designated as nondeductible. But, taxpayers can choose to designate otherwise deductible contributions as nondeductible contributions. Caution: Form 8606 is not used for the year that individuals roll over qualified retirement plan assets that included nontaxable amounts to a traditional IRA. In that situation, Form 8606 is completed for the year distributions are taken from that IRA. Failure to report nondeductible contributions. If nondeductible contributions are not reported on Form 8606, all of the traditional IRA contributions are treated as deductible contributions when withdrawn. All IRA distributions will be taxed unless the taxpayer can show, with satisfactory evidence, that nondeductible contributions were made. Penalty for overstatement. Overstating nondeductible contributions on Form 8606 results in a $100 penalty for each overstatement, unless it was due to reasonable cause. Nondeductible Contributions Create Basis Individuals who make nondeductible contributions to their traditional IRA will have basis in the IRA. The basis is the sum of the nondeductible IRA contributions minus any withdrawals or distributions of nondeductible contributions. Observation: For taxpayers who have made nondeductible contributions, traditional IRA distributions will generally include both taxable and nontaxable (basis) amounts. 6

17 Excess Contributions Generally, for 2010, an excess contribution is the amount contributed to an individual s traditional IRAs for the year that is more than the smaller of: 5,000 ($6,000 if age 50 or older) or Compensation for the year. Note: The taxable compensation limit applies whether contributions are deductible or nondeductible. Contributions for the year an individual reaches age 70½ (and any later years) are also excess contributions. Observation: Roth IRA contributions can be made after individuals turn age 70½ without incurring the 6% penalty tax, provided no more than the allowable amount is contributed to the Roth IRA. This is an advantage of Roth IRAs over traditional IRAs. An excess contribution can be the result of contributions made by the individual, his spouse or his employer contribution, or of an improper rollover contribution. Exception: Employer contributions to an employee s SEP IRA are subject to special rules. IRA Transfers Related to Divorce If a divorce or separate maintenance decree, or a written document related to such a decree, transfers an interest in a traditional IRA to the account owner s spouse or former spouse, the interest in the IRA, starting from the date of the transfer, is treated as the transferee spouse s IRA. The transfer is tax-free. An interest in a IRA transferred under a decree of divorce or separate maintenance is treated as the recipient s IRA for all purposes. For example, if the transferee is over 70½ years old, required minimum distributions must begin (unless the IRA is a Roth IRA). Caution: The transfer is tax-free only if it is specifically required by a decree of divorce or separate maintenance (or a written instrument related to such a decree). Thus, the couple must eventually divorce or legally separate. Transferring an IRA under a written separation agreement or other court order (for example a temporary support order) is not tax-free. Even when the divorce or separate maintenance decree calls for the division of an IRA between the spouses, it is important that the IRA funds be transferred directly to the receiving spouse s IRA and not first distributed to the account owner. Transfer Methods Two commonly-used methods of transferring IRA assets to a spouse (or former spouse) are: 1. Changing the name on the IRA. 2. Making a direct transfer of IRA assets. 7

18 Changing the name on the IRA. If all the assets are to be transferred, the account can be transferred by changing the name on the IRA from the original owner s to the name of the recipient spouse (or former spouse). Direct transfer. Under this method, the account owner directs the IRA trustee to transfer the affected assets directly to the trustee of a new or existing traditional IRA set up in the name of the account owner s spouse (or former spouse). If the spouse (or former spouse) is allowed to keep his portion of the IRA assets in the account owner s existing IRA, the account owner can direct the trustee to transfer the assets he is permitted to keep directly to a new or existing traditional IRA set up in his name. The name on the IRA containing the spouse s portion of the assets would then be changed to show his ownership. Inherited IRAs Individuals who inherit an IRA are called beneficiaries. A beneficiary can be any person or entity the owner chooses to receive the benefits of the IRA after he dies. Like the original owner, individuals who inherit an IRA generally will not owe tax on the assets in the IRA until they receive distributions from it. Note: Under the required minimum distribution rules, a traditional IRA must be distributed to the beneficiary over a certain period, which depends on the beneficiary s identity and the IRA owner s age at death. Options for Spouses Who Inherit an IRA Individuals who inherit a traditional IRA from their spouse generally have the following three choices: 1. Treat it as their own IRA by designating themselves as the account owner. 2. Treat it as their own by rolling it over into their IRA, or to the extent it is taxable, into a qualified employer plan, a Section 403(a) or 403(b) plan or a Section 457 plan. 3. Treat themselves as the beneficiary rather than treating the IRA as their own. In this case, special rules apply when computing the required minimum distributions from the IRA after the owner s death. IRAs Inherited From Someone Other Than a Spouse Individuals who inherit a traditional IRA from anyone other than their deceased spouse cannot treat the inherited IRA as their own. This means that they cannot make any contributions to the IRA. It also means they cannot roll over any amounts into or out of the inherited IRA. However, they can make a trustee-to-trustee transfer to a different IRA as long as the IRA into which amounts are moved is set up and maintained in the name of the deceased IRA owner for the individual s benefit as beneficiary. 8

19 IRA With Basis The deceased owner s basis in the IRA (because of nondeductible contributions) remains with the IRA. However, other than a surviving spouse who chooses to treat the inherited IRA as his own, individuals who inherit an IRA cannot combine its basis with any basis they have in their own traditional IRA(s) or any basis in traditional IRA(s) inherited from other decedents. Individuals who take distributions from both an inherited IRA and their own IRA, when each has basis, must complete separate Forms 8606 to determine the taxable and nontaxable portions of those distributions. Tax Credit for IRA Contribution Individuals who make eligible IRA (traditional or Roth) contributions may qualify for the retirement saver s credit of up to $1,000 ($2,000 if MFJ). The nonrefundable credit (figured on Form 8880) can offset regular tax and AMT. Observation: Elective deferrals to a 401(k) or 403(b) plan (including designated Roth contributions), or to a 457, SEP or SIMPLE plan, also qualify for the saver s credit. Voluntary after-tax employee contributions to a tax-qualified retirement plan or 403(b) annuity also qualify. Employee contributions are treated as voluntary as long as they are not required as a condition of employment. The credit amount is the eligible contribution multiplied by the credit rate, based on filing status and modified AGI. The maximum contribution taken into account is $2,000 per person. On a joint return, up to $2,000 is taken into account for each spouse. Qualified individuals must meet all the following requirements to qualify for the credit in 2010: Be at least age 18 by the end of the year (born before January 2, 1993). Not be a full-time student. Not be a dependent claimed on someone else s tax return. Prohibited Transactions Generally, a prohibited transaction is any improper use of a traditional IRA account or annuity by the account owner, the account beneficiary or any disqualified person. Disqualified persons include the IRA fiduciary and members of the account owner s family (spouse, ancestor, lineal descendant and any spouse of a lineal descendant). Examples of prohibited transactions with a traditional IRA include: Borrowing money from it. Selling property to it. Receiving unreasonable compensation for managing it. Using it as security for a loan. Buying property for personal use (present or future) with IRA funds. 9

20 Definition of fiduciary. For the prohibited transaction rules, a fiduciary includes anyone who does any of the following: Exercises any discretionary authority or control in managing an IRA or disposing of its assets. Provides investment advice to an IRA for a fee, or has any authority or responsibility to do so. Has any discretionary authority or responsibility in administering an IRA. Loss of IRA Status Generally, if the IRA owner or a beneficiary engages in a prohibited transaction in connection with a traditional IRA at any time during the year, the account stops being an IRA as of the first day of that year. Effect on owner or beneficiary. If an account loses its status as an IRA because the owner or a beneficiary engaged in a prohibited transaction, the account is treated as distributing all its assets to the account owner at their FMV on the first day of the year. The total FMV in excess of any basis in the IRA is a taxable distribution that, in addition to income tax, may be subject to additional taxes or penalties (for example, the 10% early distribution penalty if the owner is under age 59½). Exception: An IRA set up by an employer or an employee association does not lose its IRA status if the employer or the employee association engages in a prohibited transaction. This exception does not apply if the account owner participates in the prohibited transaction with his employer or the association. Penalty Taxes on Prohibited Transactions If someone other than the owner or beneficiary of a traditional IRA engages in a prohibited transaction, that person may be liable for certain taxes. In general, there is a 15% tax on the amount of the prohibited transaction and a 100% additional tax if the transaction is not corrected. Loss of IRA status. If the traditional IRA ceases to be an IRA because of a prohibited transaction by the account owner or a beneficiary, the person who engaged in the prohibited transaction is not liable for these excise taxes. However, the account owner may be subject to income tax due to the deemed distribution of the account. Exempt Transactions Two types of transactions are not prohibited transactions if they meet the requirements described below. Payments of cash, property or other considerations to the account owner. Even if a sponsor makes payments to the account owner or his family, there is no prohibited transaction if all three of the following requirements are met: 1. The payments are for establishing a traditional IRA or for making additional contributions to it. 10

21 2. The IRA is established solely to benefit the account owner and his (or his spouse s) beneficiaries. 3. During the year, the FMV of the payments received is not more than: a) $10 for IRA deposits of less than $5,000 or b) $20 for IRA deposits of $5,000 or more. Examples of the nominal gifts or banking services that an IRA owner can receive without creating a prohibited transaction include free checking, cash bonuses or other gifts, if the above requirements are met. If the consideration is group term life insurance, requirements 1 and 3 do not apply if no more than $5,000 of the face value of the insurance is based on a dollar-for-dollar basis on the assets in the IRA. Services received at reduced or no cost. Even if a sponsor provides services at reduced or no cost, there is no prohibited transaction if all of the following requirements are met: 1. The traditional IRA qualifying the account owner to receive the services is established and maintained for the benefit of the account owner, his spouse and his (or his spouse s) beneficiaries. 2. The bank itself can legally offer the services. 3. The services are provided in the ordinary course of business by the bank (or a bank affiliate) to customers who qualify but do not maintain an IRA (or a Keogh plan). 4. The determination, for a traditional IRA, of who qualifies for these services is based on an IRA (or a Keogh plan) deposit balance equal to the lowest qualifying balance for any other type of account. 5. The rate of return on a traditional IRA investment that qualifies is not less than the return on an identical investment that could have been made at the same time at the same branch of the bank by a customer who is not eligible for (or does not receive) these services. 11

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23 SELF-STUDY QUIZ Determine the best answer for each question below. Then check your answers against the correct answers in the following section. 1. Which of the following is a requirement of an individual retirement annuity? a. The funds placed in the account cannot be used to purchase a life insurance policy. b. The owner of the contract cannot transfer any portion of the contract to any person other than the issuer. c. All contributions added to the account for the year must be in cash. d. The assets held in the fund are not allowed to be combined with other property. 2. Steven, age 38, is self-employed and contributes to a traditional IRA account in Which of the following would not be deductible as an IRA contribution for Steven in 2010? a. Any brokers commissions paid by Steven for funds allocated to the IRA. b. Amounts Steven contributes to the IRA account. c. Separately billed trustees administrative fees paid in conjunction with the IRA. 3. Mark dies in 2010 and leaves his entire IRA account to his niece, Leslie. Which of the following is true for Leslie regarding the inherited IRA account? a. The IRA funds can be transferred to another IRA using a trustee-to-trustee transfer in Mark s name with Leslie as a beneficiary. b. Leslie can treat the IRA account as her own after inheriting it if she designates herself as the account owner. c. Leslie will owe taxes on the assets in the IRA when she inherits the IRA account from Mark, on his passing. d. Leslie can roll over the inherited IRA into her own IRA account, upon Mark s passing. 13

24 SELF-STUDY ANSWERS This section provides the correct answers to the self-study quiz. If you answered a question incorrectly, reread the appropriate material. (References are in parentheses.) 1. Which of the following is a requirement of an individual retirement annuity? (Page 2) a. The funds placed in the account cannot be used to purchase a life insurance policy. [This answer is incorrect. The stipulation that the funds in the account cannot be used to buy a life insurance policy is a requirement of an individual retirement account as stated in IRC Section 408(a).] b. The owner of the contract cannot transfer any portion of the contract to any person other than the issuer. [This answer is correct. According to the IRS Sec. 408(b), an individual retirement annuity must meet certain requirements. One of those requirements is that the contract must provide that the owner cannot transfer any portion of the contract to any person other than the issuer of the contract.] c. All contributions added to the account for the year must be in cash. [This answer is incorrect. A requirement of an individual retirement account, not an individual retirement annuity, is that all contributions, with the exception of rollover contributions, must be in cash as indicated in IRC Section 408(a).] d. The assets held in the fund are not allowed to be combined with other property. [This answer is incorrect. According to IRC Section 408(a), a requirement of an individual retirement account is that assets in the account cannot be combined with other property, except in a common trust fund or common investment fund. This is not a requirement of an individual retirement annuity.] 2. Steven, age 38, is self-employed and contributes to a traditional IRA account in Which of the following would not be deductible as an IRA contribution for Steven in 2010? (Page 5) a. Any brokers commissions paid by Steven for funds allocated to the IRA. [This answer is incorrect. If the brokers commissions are paid by the account owner, rather than out of funds in the IRA, the commissions are part of the IRA contribution and are considered deductible, although they are subject to the deduction limits.] b. Amounts Steven contributes to the IRA account. [This answer is incorrect. Taxpayers who are not covered by an employer retirement plan during any part of the year can deduct contributions to their traditional IRA for the year, up to the contribution limit, as stated in IRC Section 219(b).] c. Separately billed trustees administrative fees paid in conjunction with the IRA. [This answer is correct. Trustees administrative fees that are billed separately and paid in connection with a traditional IRA are not deductible as IRA contributions. However, they may be deductible as a miscellaneous itemized deduction on Schedule A of Form 1040.] 14

25 3. Mark dies in 2010 and leaves his entire IRA account to his niece, Leslie. Which of the following is true for Leslie regarding the inherited IRA account? (Page 8) a. The IRA funds can be transferred to another IRA using a trustee-to-trustee transfer in Mark s name with Leslie as a beneficiary. [This answer is correct. Individuals who inherit a traditional IRA from anyone other than their deceased spouse can make a trustee-to-trustee transfer to a different IRA as long as the IRA into which funds are moved is set up and maintained in the name of the deceased IRA owner for the individual s benefit as beneficiary.] b. Leslie can treat the IRA account as her own after inheriting it if she designates herself as the account owner. [This answer is incorrect. Individuals who inherit a traditional IRA from anyone other than their deceased spouse cannot treat the inherited IRA as their own. Since Leslie was Mark s niece and not his spouse, she will not be able to treat Mark s IRA account as her own and will not be able to make any contributions to the IRA account.] c. Leslie will owe taxes on the assets in the IRA when she inherits the IRA account from Mark, on his passing. [This answer is incorrect. Like the original owner, individuals who inherit an IRA generally will not owe tax on the assets in the IRA until they receive distributions from the IRA account.] d. Leslie can roll over the inherited IRA into her own IRA account, upon Mark s passing. [This answer is incorrect. Individuals who inherit a traditional IRA from anyone other than a deceased spouse cannot roll over any contributions into or out of the inherited IRA account. Since Leslie is not Mark s spouse, she will not be able to roll over the inherited IRA account into her IRA account.] 15